Consider the basic Weitzman (1974) framework of carbon emissions regulation we studied in class. Marginal cost and marginal damages curves as functions of emissions m are given by the following expressions where x represents monetary values:

x=10m (Marginal cost of emissions)

x=2m (Marginal damages of emissions)

Suppose, however, that the emissions control agency does not observe the true marginal cost of emissions, but only its slope. Namely, the emissions control agency overestimates true marginal costs of emissions by using the following expression when designing carbon-pricing policy:

x=15m

1. Compute the optimal price of emissions in this setting - i.e. the price that equates marginal damages of emissions with true marginal costs. (10 pts.)

2. What is the efficiency loss when the emissions control agency puts in place a cap-and-trade system? (10 pts.)

3. What is the efficiency loss when the emissions control agency puts in place a carbon tax? (10 pts.)

4. Suppose you're hired for issuing a policy recommendation to the emissions control agency oriented to minimize the efficiency loss due to uncertainty. Would you suggest a quantity-based approach or a price-based regulation? What is the economic principle driving your suggestion? (10 pts.)